BHP approaches sliding doors moment at Olympic Dam

Only after dusk has fallen on the red soil around Roxby Downs will the bettongs dare to emerge from their burrows.

Under cover of night they graze for seeds and roots within a fenced reserve that protects them from the introduced species that have wiped them from every other part of the Australian mainland.

The reserve was created with the help of BHP, which is ironic, as cynics might say the bettongs are not the only protected species in this remote part of South Australia

Unlike most copper mines, Olympic Dam has a smelter producing cathode on-site, making it a particularly complex operation. Aaron Bunch

Twelve years after it arrived through the acquisition of Western Mining Corporation, the copper mine up the road from the bettong enclosure, Olympic Dam, still clings to a niche within the BHP ecosystem.

Its survival comes despite a long-running failure to fulfil its potential, whispers of cultural problems and regular breakdowns of key equipment.

As far back as 2011 BHP chief Marius Kloppers was talking about assets needing to "earn their place in the portfolio", while his successor Andrew Mackenzie has sharpened the focus on "shrinking to greatness", most notably through the demerger of South32.

The light on the hill for BHP is to invest in large, long life, low-cost, expandable assets in good jurisdictions that generate strong returns, with a growing preference for assets that are simple to operate.

"Olympic Dam as it stands today is not of a BHP scale, it is not where we want it on the cost curve and it is certainly not generating BHP-like returns," BHP's Minerals Australia president Mike Henry said. Philip Gostelow

The geological resource at Olympic Dam is large, long life, expandable and located in arguably the world's best mining jurisdiction. But the mine is not large on a global scale, it has never been low-cost, never been particularly profitable and nor will it ever be simple to operate.

"Olympic Dam as it stands today is not of a BHP scale, it is not where we want it on the cost curve and it is certainly not generating BHP-like returns, so there is a clear recognition that the Olympic Dam of today isn't what we want to have in the future," BHP's Minerals Australia president Mike Henry said.

Which begs the question; how did this very complex, unreliable mine ranking in the expensive half of the copper cost curve survive the chop that claimed so many other BHP assets in recent years?

Consistent inconsistency

Over the past four years, Prominent Hill's weakest quarterly copper production was 74.6 per cent of its best quarterly copper production result.

Over the same period, Olympic Dam's weakest quarter delivered just 21.2 per cent of its best quarterly result.

There's one important difference between Olympic Dam and Prominent Hill that explains much about their contrasting performance.

Olympic Dam's ore has a higher uranium content, which forced Western Mining to build refineries and smelters to separate the uranium and then turn the copper into sheets of metal called cathode, which are effectively the finished product.

Prominent Hill's lower uranium levels mean it can export the copper in an intermediate, concentrate form and leave someone else to smelt it into metal.

The extra infrastructure has often been the source of Olympic Dam's outages, made Olympic Dam more complex to operate and more expensive to expand.

Advertisement

In this regard Olympic Dam is at odds with BHP's strive for simplicity, which has seen the company exit assets with downstream processing, like alumina refineries and manganese smelters.

Complexity might be tolerated if it is lucrative, but Olympic Dam is not a major money-spinner, delivering just $US60 million and $US39 million of earnings before interest and tax (EBIT) in the past two years for an EBIT margin of just 3 per cent and 4.6 per cent respectively.

BHP's Antamina and Pampa Norte copper assets have delivered hundreds of millions of dollars of EBIT in those years, while Chile's Escondida mine has generated billions of dollars of earnings.

If Olympic Dam is not simple, low-cost nor particularly profitable, which BHP strategy boxes does it tick?

The fact it produces copper, which is universally tipped to fetch strong prices over the next decade, is not enough to ensure retention.

While BHP does want more copper in its portfolio, it recently sold the Cerro Colorado copper mine because it was not elite by global standards.

The true appeal of Olympic Dam for BHP lies in its expandable nature; at current production rates and resource estimates BHP could continue mining the asset for 500 years.

Expansion difficult

Advertisement

BHP hopes that a future expansion of Olympic Dam will also turn one of the mine's brickbats – its high production costs – into a bouquet, as greater volumes improve unit costs and ultimately profits.

That is fine in theory, but expanding Olympic Dam has proved much harder than expected.

Several expansion plans have come and gone over the years, with the latest approach known as BFX, which is shorthand for Brownfield Expansion.

BFX would expand Olympic Dam's smelter, mill and refinery on the surface, while also accelerating and expanding the underground mining operations into an area of higher copper grades.

The plan would lift copper production from today's annual capacity of 220,000 tonnes to 330,000 tonnes, and BHP believes that improved scale would make Olympic Dam cheaper to operate than 75 per cent of the world's copper mines.

While studies are still under way, Mr Henry says the Olympic Dam team have outlined a "credible path to grow" through BFX, which could be a platform for subsequent growth projects.

"It is not the big bang approach, it is a couple of tranches of growth for digestible chunks of capital, and largely based on activity that we already undertake, just doing more of it," he said,

If approved, the project would cost about $US2.1 billion for a rate of return of about 20 per cent.

Advertisement

On those metrics BFX would clear most companies' investment hurdles; OZ is building a new copper mine 100 kilometres south of Olympic Dam which has a rate of return of "circa 20 per cent".

Sliding doors moment

But within a diversified portfolio like BHP's, competition for capital is fierce, and the company's other divisions like iron ore and coal are promising rates of return of 30 per cent to 80 per cent for their best expansion projects.

"The asset [Olympic Dam] will not be of the scale that we want and can't generate the sort of returns we would like without being able to expand, because it is a relatively high fixed-cost asset. The flipside of that is every increment of expansion yields you pretty attractive returns," said Mr Henry.

The BHP board is scheduled to take an investment decision on BFX in 2020, and that decision looms as BHP's sliding doors moment; if BFX, like previous Olympic Dam expansion plans, cannot compete for capital against BHP's other options, will it be time to sell?

Mr Henry was asked that question by analysts in November 2017, to which he answered, "At this point in time certainly not looking at those sorts of opportunities".

BHP's stance does not appear to have changed since then.

But some believe a sale is worth considering at a time when markets are bullish on the copper price outlook,and when copper mines are trading hands at what Rio boss Jean-Sebastien Jacques calls "good prices for the sellers"..

"If the market is ripe with copper buyers, why wouldn't you look to be contrarian," said Shaw and Partners analyst Peter O'Connor.

"Forget the buzz around copper, forget the famous name, forget the fantastic jurisdiction. Does this make financial sense for our shareholders, yes or no? Are we going to get a return on capital in excess of our cost of capital which competes with the other growth options in our portfolio? If the asset can't fulfil those obligations without spending large additional chunks of capital, the question should be asked, why are we keeping it?"